MAF203 Lecture Notes - Lecture 8: Risk Premium, Private Equity, Initial Public Offering
Document Summary
Capital structure: the mix of sources of funds (debt and equity) used by a company to finance its activities. Equity financing = when a company uses equity to raise funds it means it has: Shareholders have the right to sell their shares in secondary market: floating public company (ipo) = invites public to subscribe to buy shares, p(cid:396)i(cid:448)ate e(cid:395)uity = se(cid:272)u(cid:396)ities issued to i(cid:374)(cid:448)esto(cid:396)s that a(cid:396)e(cid:374)"t pu(cid:271)li(cid:272)ally t(cid:396)aded. Involves a contract whereby the borrower promises to pay future cash flows to the lender in the form of interest payments and repayment of amount borrowed. No management control le(cid:374)de(cid:396) has (cid:374)o (cid:272)o(cid:374)t(cid:396)ol o(cid:448)e(cid:396) (cid:272)o(cid:373)pa(cid:374)y"s ope(cid:396)atio(cid:374) Value of firm (v) = value of debt (d) + value of equity (e). There are 3 ways to measure financial leverage/gearing: debt/equity ratio, debt/capital ratio, capital = value of firm. Increasing leverage involves a trade-off between risk and return. Effect of debt: substitution of debt for equity in the capital structure.
